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baselineace (< 20)

Gold isn't safe either

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July 26, 2010 – Comments (14) | RELATED TICKERS: GLD , IAU , DJP

Gold may not be such a safe haven after all.

Momentum has cooled since gold prices reached a nominal record high around $1,260 a troy ounce just weeks ago. Don't be surprised if that level is not revisited.

Gold prices have gone berserk in the second quarter of 2010, more so than in any other period during the past two years. Recently, gold has also fallen out of sync with the DJ-UBS Commodity Index (see chart), indicating that the market is not properly valuing commodities. This could be cause for concern. Furthermore, manufacturing demand for gold has shrunk drastically, due in large to declining jewelry sales. Investors last year bought more gold than buyers of jewelry for the first time in three decades, the Financial Times recently reported. Such alarming data should be reason enough to steer clear of precious metals.

Despite these risks, investors are still flocking to gold for a number of reasons. Everywhere we go, we are bombarded with advertisements telling us why we should dabble in gold. (Heck, even Mr. T wants your gold!) Pundits continue to urge us to buy gold as protection from inflation and as a hedge against currency devaluation. I even witnessed one "expert" suggest that gold was a good hedge against deflation. Then there's that outrageous apocalyptic view that the world economy will collapse, and whomever holds the most gold at the time will prosper. According to these views, it seems one could do no wrong in ever buying gold! This belief continues to fuel the virtuous cycle that is propelling high gold levels. The culmination of these factors presents the illusion of a sound investment.

Wall Street loves this scenario, as it does all bubbles, riding them out for all they're worth. As with any asset bubble, investment bankers trade on the back of widespread belief and consequently drive up market prices, even when underlying fundamentals are less than attractive. Increased liquidity in the market, visa-vie exchange-traded funds, makes it easier than ever for bubbles to form and be played.

Proponents are quick to remind everyone that gold is still a long way from its record inflation-adjusted high above $2,300 an ounce in 1980. To put things in perspective, the hot-button issue back then was hyperinflation, which drove the price of commodities through the roof. Baby boomers were reaching their prime spending years. The federal funds rate at the time was over 10 percent, compared to almost zero percent today. Nevertheless, many investors are increasingly concerned about inflation. This time, the worry is that the central bank's massive monetary expansion (a.k.a. stimulus) will yield nasty inflation. Consumer price index data however suggests that inflation is nowhere in sight. With interest rates so low, any unwanted inflation that does result can easily be suppressed by way of raising the federal funds rate. Therefore, buying gold to protect against inflation doesn't seem to jive either.

Savvy investors know that no investment is infallible, and that nothing can go up indefinitely. There's no such thing as a "safe investment". At $1,200 an ounce, gold still trades at a dangerous level. In fact, some Wallstreeters have already began moving away from gold. "Smart money" interests, including George Soros, Jeremy Grantham (GMO) and those at Goldman Sachs, began reducing their gold ETF positions in the first quarter of 2010.

The high price of gold is buoyed by artificial life support by way of synthetic instruments and irrational fears. Ultimately, though, its current level is unsustainable. It's only a matter of time before the gold bubble bursts, dragging other commodities down with it.

14 Comments – Post Your Own

#1) On July 26, 2010 at 7:43 AM, MoneyWorksforMe (< 20) wrote:

Well doesn't this sound familiar...Nothing new here. This could have been copied and pasted in its entirety from any gold bear article on the internet.

The only thing you forgot to mention was that the National debt is not problematic; and the U.S. may just print money to surmount its enormous debt problem. 

-1  

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#2) On July 26, 2010 at 7:54 AM, ryanalexanderson (< 20) wrote:

I even witnessed one "expert" suggest that gold was a good hedge against deflation...According to these views, it seems one could do no wrong in ever buying gold!

Gold has been a currency for thousands of years. Currencies do well in times of deflation. Believing gold to be a currency, not a commodity, should take care of most of your concerns you've expressed. But it seems mysteriously hard for people to do. Jewelry production is irrelevant - it's just a prettier way of storing your currency. 

There is one environment in which one could "do wrong in buying gold" - that's the scenario of a stable money supply, no sovereign risk, a positive demographic wave, and expanding private sector investment opportunities. If you think we're seeing that in the next five years, dump your gold. 

Or, if you think that the price of gold has gone into parabolic price hysteria, dump your gold. However, a look at the chart over the last 10 years looks like a calm, steady bull market to me.

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#3) On July 26, 2010 at 8:31 AM, drgroup (68.89) wrote:

Buying gold is like the dog chasing the bus. Once the dog catches the bus, what does he do with it? I took one of my gold coins to the gas station to purchase petrol. The attendant would not accept it for the purchase. He said the world had to be coming to and end first and then said he he did not know the spot price of gold at that time. I wish the world would come to a crisis large enough for me to be able to use these gold coins as a means of barter. It would sure impress my neighbors.

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#4) On July 26, 2010 at 10:22 AM, outoffocus (23.50) wrote:

drgroup

 I took one of my gold coins to the gas station to purchase petrol. The attendant would not accept it for the purchase. He said the world had to be coming to and end first and then said he he did not know the spot price of gold at that time.

You can say the same thing about the Euro, yet the Euro is a currency.  You cannot take the Euro to an american gas station and get gas.  You can however exchange your Euro for dollars and then buy gas with those dollars.  The same can be said for gold.  If you bought your gold coins last year at under $1000 per ounce, though you would not be able to exchange that gold coin for gas at the gas station, you could exchange that coin for almost $1200 in American dollars and be able to buy $200 more in gas than you would if you had kept that money in cash.  No armegeddon needed.

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#5) On July 26, 2010 at 12:44 PM, MegaEurope (20.41) wrote:

"There is one environment in which one could "do wrong in buying gold" "

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#6) On July 26, 2010 at 4:23 PM, ryanalexanderson (< 20) wrote:

Well, thank you for that chart. Pretty much proves my point, seeing as the majority of the chart - pre-1971 - is when the dollar was on the gold standard. And gold has been kicking ass ever since said standard was dropped. 

If you're advocating a return to the gold standard, hallelujah brother! Sign me up for some equity purchases once we stabilize the money supply. 

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#7) On July 27, 2010 at 11:40 AM, ajm101 (32.98) wrote:

Sigh.  Hope you wore asbestos underpants.

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#8) On July 27, 2010 at 4:16 PM, baselineace (< 20) wrote:

Sorry my chart isn't showing up. See below.

Of course things have changed with today's declines... 

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#9) On July 27, 2010 at 7:29 PM, MegaEurope (20.41) wrote:

"There is one environment in which one could "do wrong in buying gold" - that's the scenario of a stable money supply, no sovereign risk, a positive demographic wave, and expanding private sector investment opportunities."

This obviously does not describe the entire 190 years (1801-1971, 1981-2000) when stocks massively outperformed gold.

Germany, Austria, Hungary, Poland, Russia, Spain, Portugal, Greece, most of Africa and pretty much every Latin American country defaulted during that time.

Runs on banks (including central banks) were common. So gold pegs were not totally successful at ensuring a stable money supply.

Population growth is not positively correlated with stock market returns (or gold returns).

And finally, I don't think the outlook for global equities is significantly worse than the last 210 years.  For government bonds, sure, it is somewhat worse than average.  For currencies, it is way worse than average.  But it doesn't really matter: holding cash as a long term investment in 1800 was stupid too.

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#10) On July 29, 2010 at 3:57 PM, chk999 (99.97) wrote:

There are two different issues here that have different answers. That chart addresses the first question which is "Is gold a good long term investment". The answer to that is no.

But this has nothing to do with the second question, which is "Is gold a good investment now". The answer to that depends on your views on inflation rates for the near and medium term. If you think that high inflation is inevitable, then gold is a great way to preserve purchasing power. 

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#11) On July 29, 2010 at 11:41 PM, MegaEurope (20.41) wrote:

The long term has the habit of arriving unpredictably.

Lots of people say, "I'll get out at the gold top and the equity bottom."  I don't believe them.  Especially because some people form emotional attachments to their investments.

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#12) On September 11, 2010 at 4:41 PM, baselineace (< 20) wrote:

chk999, It's also important to remember that gold is a leading indicator of inflation, so forthcoming inflation may already be incorporated into the spot price.

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#13) On December 28, 2010 at 11:17 PM, ironsam (< 20) wrote:

Gold is over $1,400 an ounce as of today...where are some other articles of yours so I can do the exact opposite?

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#14) On January 28, 2011 at 2:29 PM, baselineace (< 20) wrote:

The secular outlook for gold continues to look bleak, short of a return to the gold standard.

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